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10 Small Caps to Rule Them All

Small-cap companies are absolutely one of my favorite areas to research because you can often uncover hidden gems that analysts have neglected or simply not discovered yet. They can offer the ultimate risk-vs.-reward ratio, but they are not for the faint of heart.

This 10-week series is dedicated to finding the 10 small caps to rule them all. Here are the previous five choices:

Golden Star Resources

BuffaloWild Wings

Integrated Silicon Solutions

True Religion Apparel

Allegiant Travel

This week I want to step out of the box and highlight promising biotechnology upstart Aeterna Zentaris (Nasdaq: AEZS) .

What it doesDespite its name sounding like a planet found in a bad 1980s sci-fi movie, the company deals in the serious business of oncology and endocrinology research. Don't let the company's market value of just $159 million fool you -- Aeterna Zentaris is more than just a one-trick pony.

The company has 11 prospective drugs in its pipeline at the moment; perifosine is its lead candidate for success. Perifosine, currently in phase 3 trials, has received fast-track status and has been given the designation of orphan drug as a treatment for multiple myeloma and colorectal cancer. On the endocrinology side of its business, the company's lead candidate is Solorel, an oral compound also in phase 3 trials that can be used to test for human growth hormone deficiency.

How it stacks upAs you can tell, this is where valuing a biotechnology stock can get a little sticky; especially a small startup like Aeterna Zentaris. Whereas the companies I've profiled thus far made the cut because of their strong growth yet underwhelming stock performance, Aeterna Zentaris has only one marketable product to date, Cetrotide, which is an in vitro fertilization drug administered to women to prevent premature ovulation.

Having only one drug approved by the Food and Drug Administration and receiving drug milestone payments infrequently, we need to use more creative methods to see why Aeterna Zentaris is a clear buy and its competitors aren't.

Comparing drug companies can be even more difficult than trying to compare an apple to an orange because of how many drugs they have in their pipeline as well as what the potential market will be like for drugs under development. For the sake of argument, I made an attempt to pick out biotech companies with similar market values and left out the very few drugs that have already made it to market. Instead, I feel it's more important to focus on the drugs currently in the pipeline because investors are looking toward the future with biotechs, not the past.

Based on the above figures, Aeterna Zentaris has a clear advantage. The company consistently has a steady stream of drugs in late-stage clinical trials compared to a company like Geron, which currently doesn't have a prospect past phase 2 clinical trials. Orexigen, you may notice, is batting 1,000, but considering it has only two drugs in its entire pipeline, the chances of failure go up considerably. ImmunoGen may also seem like a tempting bet, but considering that 90% of its prospects have yet to make it past phase 1 clinical trials, it languishes in comparison to Aeterna Zentaris.

How it could make you moneyAnother way to interpret the figures above is to consider what market value is being assigned to each company based on the drugs currently in the pipeline.

Company

Drugs Under Development

Current Market Value

Value per Drug

Aeterna Zentaris

11

$159M

$14.5M

Geron

10

$635M

$63.5M

Zalicus

9

$201M

$22.3M

Orexigen Therapeutics

2

$140M

$70.0M

XenoPort

6

$314M

$52.3M

ImmunoGen

10

$806M

$80.6M

Despite having drug candidates further along in the approval process than many of its rivals, Aeterna Zentaris has the lowest market value-to-drug ratio of the bunch -- and it shouldn't. If Orexigen can muster an average current value of $70 million per prospective drug in a hypercompetitive anti-obesity drug market -- which is currently on pace to deliver more than $3 billion in sales by 2016 -- then Aeterna Zentaris certainly deserves a more realistic valuation. The multiple myeloma market alone is set to grow to $5.3 billion in sales by 2018 and makes Aeterna Zentaris look like a moderately undervalued prospect at these levels.

Another aspect worth considering in the biotech sector is whom the company is partnered with. Occasionally, companies will go it alone and research and subsequently market a drug themselves. More often, though, it's considerably more beneficial for small biotech companies to form drug pacts and share knowledge and cash in order to facilitate getting a drug to market.

For perifosine, Aeterna Zentaris has allied itself with Keryx Biopharmaceuticals (Nasdaq: KERX) and Handok. Keryx holds the licensing for perifosine in the U.S., Canada, and Mexico, Handok holds the rights in Korea, and Aeterna holds the rights everywhere else. The most important aspect of this deal is that Aeterna gets to use data collected during the phase 3 trial free of charge in order to facilitate its application of the drug in Europe with basically minimal costs. Assuming perifosine gains approval, and every test thus far has generated positive data, it's my opinion that the company should have no trouble generating massive gross margins.

What are your feelings on Aeterna Zentaris? Biophobic or biophilic? Let's hear your thoughts in the comments section below. Also consider adding Aeterna Zentaris as well as your own personalized portfolio of companies to the free and easy-to-use My Watchlist.

Fool contributor Sean Williams owns shares of Golden Star Resources but has no material interest in any other companies mentioned in this article. He would like to remind you not to forget about our friends in Japan who could still use a helping hand. You can follow him on CAPS under the screen name TMFUltraLong.Buffalo Wild Wings is aMotley Fool Hidden Gemsselection.ImmunoGen is aMotley Fool Rule Breakerschoice. The Fool owns shares of Allegiant Travel. Try any of our Foolish newsletter servicesfree for 30 days.We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policythat's up to date on all its vaccines.

Comments from our Foolish Readers

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I could not agree more Mr Williams, I have owned this stock when it was below $1 and have been giving my humble opinion a few times that it would double from that very low number and it has.

IMHO this stock has a tremendous pipeline and like Mr Williams said Perifosine is in phase III with the decision to be approved in early this fall. The deal in Japan was huge for aezs, not only did they receive $8.3 million up front but as part of this agreement aezs could receive an additional $61 million in payments for achieving certain pre-established milestones including clinical and regulatory events in Japan. In addition, AEZS will be supplying perifosine to Yakult Honsha on a cost-plus-basis and is entitled to receive double-digit royalties on future net sales of perifosine in Japan with Yakult Honsha being responsible for the development, registration and commercialization of Perifosine in that country. In 2019, the colorectal market in Japan is expected to be $1.3 billion and the multiple myeloma market is expected to be about $540 million. Mr Williams also reminded us LONG aezs holders that we also have a partnership with Kerx and Handok. This stock will be gaining momentum as we near ASCO and be on fire when the FDA gives it's approval.

I think MR Williams has spelled it out to us about the strong pipeline aezs has and the possibilities for this stock to be huge. I am still buying at these low prices and once the MM have a accumulated their stockpile then we will never see these sale prices again.

Thank you Mr Williams for sharing your thoughts with us. Also with your track record this will make us long holders to be even more patient and not worry about the pennies being traded lately.

A little 1-sided and simplistic to try to use a pure development portfolio numbers game to value a company. A more diligent look, that accounts for scientific and management risk would provide further texture and understanding that may change (or reinforce) this conclusion.

1. Lots of programs may not mean lots of progress! With a small market cap/less available cash, do AEZS have the ability to fund and resource this portfolio for success? Are the other programs diluting effort from perifosine which is positioned to be the key for success? Lots of underfunded programs translate to little progress, lower chance of success (in a business that is already risky) and wasted money.

2. Lots of programs may not mean lots of scientific opportunity. How good are the products? A quick perusal will show that other than perifosine, their cancer portfolio is not terribly novel or innovative. Thus, simply getting a program to Ph2 does not mean that it has value.

3. Lots of programs may mean indecisive leadership. Is the big portfolio an indication of a poor management team that does not know how to focus?

Do not know all the answers, but without better information, a pure numbers game might be misleading

Looking for a nice small cap? Try GRC. A nice boring business with products that can't be done without by a suprisingly large number of industries. They aquire excellent complimentary businesses at reasonable costs and are well positioned for solid, steady growth. Manageable debt, consistent if unspecatular dividend growth, strong and well alligned leadership. So what do they do? Pumps, friendo, pumps. Do I own some? Yes I do.

I think these comparisons are for relatively less risky companies than those I deal with. I consider the above companies relatively 'safe'.

My current large holding is ACTC and it is very risky on the outside but inside it looks like a slam dunk. When the first people either regain their sight, or have their progression to blindness stopped and reversed, then you will 'discover' it. Their pipeline is also filled with potential in many areas of regenerative medicine, including blood from stem cells. I think 2011 will be a banner year.

Sending report...

A Fool since 2010, and a graduate from UC San Diego with a B.A. in Economics, Sean specializes in the healthcare sector and in investment planning topics. You'll usually find him writing about Obamacare, marijuana, developing drugs, diagnostics, and medical devices, Social Security, taxes, or any number of other macroeconomic issues. Follow @TMFUltraLong